PUB. 11 2021-2022 Issue 2

July • August 2021 21 How do these potential alternative benchmark rates compare? While credit-sensitive rates respond to changes in market conditions, for example, raising in times of economic stress, risk-free rates such as SOFR are less responsive to the market. They may even decrease in times of economic stress. Because a component of cost for financial institutions is tied to credit-sensitive rates, the use of SOFR as the benchmark could leave lenders with higher costs and lower SOFR-benchmarked returns in times of economic crisis. However, if Term SOFR does arrive as soon as recent developments indicate, lenders may become more comfortable with SOFR and its perceived stability, given the current market support from institutional market players. Further, the concept of Term SOFR offers lenders comfort with familiarity due to its similar nature in concept to LIBOR. The similarities and differences of each leading replacements rate are summarized in the below table. Is the Prime Rate a viable replacement to LIBOR? Many existing loan documents currently include a fallback to the Prime Rate if LIBOR ceases to be available. Prime Rate is the rate banks give to their “most favored customers.” The Prime Rate is a consumer interest rate based on creditworthiness. In contrast, LIBOR is a rate calculated based on transactions between banks. As a result, any conversion to the Prime Rate will increase the interest rate paid under loan agreements unless a negative spread adjustment is made. The Prime Rate and LIBOR are both CSRs. However, the Prime Rate includes a much larger implicit spread, so the Prime Rate does not easily substitute for LIBOR. Is a Multi-Rate Environment in Our Future? As noted above, most banks are weighing the benefits of one or more benchmark rates to replace LIBOR. At the moment, SOFR based rates are in the lead, but CSRs are in contention. ACH replacement rate choice has pros and cons, and the decision depends on economic and operational considerations, which are specific to each bank. As a result, a multi-rate lending environment seems likely in the foreseeable future. Daniel Bray is a Denver-based partner with the law firm Husch Blackwell LLP and leads the firm’s Banking & Finance group. Replacement Rate Rate known in advance of interest period? Requires Robust Calculating? Is the Rate Credit Sensitive? Strengths & Weaknesses Term SOFR Y N N Supported by industry leaders; allows for simple replacement; SOFR already being used widely in loan documentation amendments; questions about hedging. SOFR Compounded in Advance Y N N Easy to implement into current LIBOR facilities; difficult to match credit sensitivity in markets; questions about arbitrage. Daily Simple SOFR N N N Not similar to current LIBOR loans; fails to offer flexibility for more credit- sensitive borrowers; provides ease of calculation. Credit Sensitive Rates Y N Y Easily substituted for LIBOR; Lacks support from institutional lenders; less robust than SOFR.